Insider trading inside out

Published 4:00 am, Sunday, June 15, 2003

Investors who have been clamoring to see cheating CEOs thrown into the slammer undoubtedly were delighted last week when Sam Waksal was sentenced to seven years and three months for breaking insider trading and other laws.

That's partly because illegal insider trading, like murder, is often unpremeditated.

When people stumble onto market-moving information, they often have little time to act on it. Pumped with adrenaline and dreaming of riches (or avoiding losses), they might not think through the consequences of trading on non- public information.

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"It's not often a nefarious plot," says Bruce Brumberg, who produced two videos that warn employees about insider trading. "People just lose their values."

Or in some cases, their minds.

On Dec. 26, 2001, when he was chief executive officer of ImClone Systems, Waksal learned from his brother Harlan, who was ImClone's chief operating officer, that the Food and Drug Administration would reject an application for the company's leading drug on Dec. 28, 2001.

During the next two days, Waksal tried to sell his shares by transferring them first to his daughter. Two brokerage firms refused to sell the shares because they had been Waksal's and were subject to trading restrictions. Waksal also persuaded his father and daughter to unload their own shares and told his daughter to lie about the reason for the sale, according to court documents.

Waksal was indicted in August on 13 counts of securities fraud, conspiracy, perjury and obstruction of justice. In October, he pleaded guilty to six counts, including tipping off his daughter, but not his father. In March, he pleaded guilty to separate tax fraud and conspiracy charges for evading sales tax on artwork.

During sentencing, Judge William Pauley rejected defense arguments that Waksal's insider-trading crimes were "spur of the moment."

EASY TO GET CAUGHT

Even when they have time to consider the consequences, some people trade on inside information anyway. Like criminals everywhere, they gamble on not getting caught.

"Maybe 10 years ago, it was pretty easy to get away with," says Peter Romeo,

an attorney with Hogan & Hartson.

Today, it's not.

"The surveillance techniques have been improved, and the companies themselves are exerting a lot of oversight," says Romeo.

The stock and options exchanges monitor price and volume in individual securities, using artificial intelligence to flag trades that fall outside certain parameters.

When trading looks suspicious, the exchanges may refer the case to the Securities and Exchange Commission or U.S. attorneys.

Investigators can obtain the names and addresses of everyone who traded stock or options at a particular moment, even if the trade was made in "street" or the brokerage firm's name.

Investigators can look for clusters of names in the same ZIP code or the same country club.

"We can subpoena bank records, telephone records. Most conversations are taped by brokerage firms," says Paul Berger, the SEC's associate director of enforcement. "If you made a trade by a computer, we can track down the IP address and find the computer the trade was made from."

RATIONALIZATION

Some people trade on inside information after convincing themselves it's not illegal or harmful to anyone.

"They rationalize it," Brumberg says. "They say, 'Maybe I shouldn't have had the information, but it's not a big deal. I'll probably be able to explain it another way.' Or they'll say, 'I heard this, but it's my own smarts that figured it out.' "

According to the Securities and Exchange Commission, Stewart sold almost 4, 000 shares of ImClone stock on Dec. 27 after she heard from her broker, through his assistant, that the Waksals were selling their shares.

Stewart, a close friend of Waksal, says she had a pre-existing order with her broker to sell the shares if they dropped below $60. She pleaded not guilty to the SEC's civil insider-trading charge laws and to federal criminal charges that in covering up the alleged crime, she obstructed justice.

No one has alleged that Waksal told Stewart directly that the FDA decision was imminent.

"She heard the Waksals were selling, she made the connection," says Brumberg. "But you have to be careful. You think you're smart about drawing inferences, but in hindsight, the SEC might say anyone would have drawn this inference" and as a result, that trading on the information was illegal.

NEW THEORY

Because there's no clear evidence that Waksal tipped Stewart, the SEC is using the relatively new "misappropriation" theory, according to Jared Kopel, an attorney with Wilson Sonsini Goodrich & Rosati.

"They're saying the fact that Waksal and his daughter were trying to sell (ImClone stock) was information that belonged to them and to Merrill Lynch," the brokerage firm for Waksal and Stewart, Kopel says.

In other words, Peter Bacanovic, the former Merrill broker who handled Stewart's account, allegedly stole the information, and Stewart allegedly received stolen goods.

"The legal theory in the Martha Stewart case is treading new ground," says Romeo.

Like most insider-trading cases, this one won't be easy to prove.

"It's not often there's a smoking gun," Romeo adds. Prosecutors "have to piece together events that look suspicious."

SEC CASES RISING

The number of insider-trading cases filed each year by the SEC has crept up during the past decade. In 1993, it filed 31 such cases, which represented 7 percent of all securities-related cases it filed that year. In 2002, the SEC filed 59 insider-trading cases, which accounted for 10 percent of all cases.

Public companies have strict rules prohibiting all employees from trading on or passing along material non-public information.

Normally, top executives can only trade stock only during windows that typically start a day or two after quarterly earnings and last for 30 to 60 days.

Some companies require top executives to get all personal trades pre- approved, not just to prevent illegal insider trading but also to meet other federal rules limiting insider stock trades.

Some companies use videos or Web-based programs to educate and scare employees.

RIPPED FROM THE HEADLINES

Brumberg's first video, called "Think Twice," came out in 1991. It's a docudrama that follows a group of employees at a fictional company who trade illegally and get nailed.

The movie stars former SEC Commissioner Harvey Pitt as a defense attorney. It was shot when Pitt was a private attorney.

"Think Twice: The Sequel," came out last year. It was shot in a flashier style similar to the TV show "Law and Order."

Although insider-trading laws haven't changed much since the first video was made, Brumberg says, "the ways you can get in trouble have."

Many companies worry that employees will leak inside information on Internet message boards.

It's also easier to get caught.

"The stock exchanges have more resources. They have a lot of sophisticated data mining and matching programs," Brumberg says.

The Sarbanes/Oxley Act passed last year increases the penalties for insider- trading violations, and allows prosecutors to bring cases more quickly.

All of these changes may have a chilling effect on illegal insider trading. But Waksal's sentence, by itself, is unlikely to have much impact, especially if he -- like Michael Milken -- gets sent to a country club prison and gets time off for good behavior.

Waksal asked to be sent to a minimum-security prison in Florida to be near his parents. The Bureau of Prisons will decide where to send him.

"People have been going to prison for insider trading for a long time," says Kopel. "It's a rush to judgment to say that because one person is going to prison for insider trading, everyone else will stop."

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